Top Three Liquidity Risks for Manufacturers
We live in challenging times and for the manufacturing sector this means increased pressure on its requirements and a need to rebuild stability. For this, liquidity is fundamental.
While well-known by those in the sector, the following three key risks have been heightened by the COVID-19 crisis; tackling these areas will be essential for a manufacturing firm’s resilience.
Access to stable supply chain
In the early stages of the COVID-19 crisis, businesses were closed for several months, and so were borders. The challenges this presented become all the more evident when we consider that more than 70% of the global manufacturing industry has been supported by China. This caused severe disruption to global supply chains as backlogs of raw materials mounted.
Without raw materials, and with a depleting supply of finished goods, it was nearly impossible for manufacturing firms to remain competitive in their marketplaces, and the threat to liquidity became all the more acute. The COVID-19 crisis has demonstrated the need for manufacturing companies to diversify their supply chains.
Maintaining a stable cash flow
Manufacturing companies have always needed to have a firm grip on their cash flows and liquidity requirements, as they have a number of areas to look after such as fixed overheads, machinery maintenance, labour cost, vendor payments, and other debt obligations. In order to maintain a constant source of liquidity, their customer payment side of the cycle needs to be stable. This has been challenged significantly in the current climate, with lockdowns affecting the entire supply chain and also stretched payments from their customers due to variety of reasons. In Middle East region, we have seen average collection period has gone up by 60-90 days and in few industries even more, and this has resulted in manufacturing companies to either negotiate payment terms with vendors, restructuring/enhancement of bank facilities or even letting go few large customer relationships due to liquidity strain.
Ability to meet debt obligations to financial institutions
Manufacturing companies require large set-ups, often with significant capital investments on infrastructure and asset base. These asset bases are financed by banks, particularly where a company is in its growth phase. As such, they will often have an associated payment, whether that be for principal or interest. If manufacturing companies are facing a liquidity crunch, whether due to delayed customer payments, or not being able to work in full capacity or any market dynamics or industry shifts, they will not be able to meet their debt obligations to banks. If this continues, banks will have to look at either restructuring of the facility or may even lead to confiscation of company assets.
How COVID-19 has amplified costs
As well as understanding current key risks to liquidity, it is important to take stock of how and where COVID-19 has amplified costs.
One of the clearest cost increases has been that of raw materials - this has been dictated by limited supply and rising demand. Beyond this, however, there are a number of less obvious cost increases.
The COVID-19 crisis has amplified liquidity risks in a number of ways. The impact that the pandemic has had on the workforce is substantial. Manufacturing is a labour-intensive industry; as such, firms have not been able to take as much advantage of the shift to home working as other sectors.
Maintaining a safe working environment for the workforce has been key - but this comes at a price. The provisions needed to combat the pandemic have led to significant cost increase for some manufacturers. In many instances, essential specialised equipment was shared among workers - safety gloves for example. Now, to prevent the spread of the virus, workers need their own specialised equipment and protective kits, resulted in increased expenses.
Furthermore, where a factory or plant requires social distancing and increased safety measures, there is likely to be a drop in productivity for the business as a whole.
Due to the impact that the crisis has had on manufacturing, financial institutions are more cautious when working with the sector. Banks are more reluctant to support manufacturing firms when their counterparts with very similar offerings have gone bankrupt. This has proved somewhat restrictive approach for firms trying to operate during this challenging time.
When the crisis started, trade credit insurers started to withdraw credit limits across the world. This occurred on such a large scale that suppliers are no longer able to offer manufacturers the 90-120 days of credit they were used to. Manufacturers are now having to make up-front or even advanced payments for materials, while also having their receivables stretched by up to an additional 90 days.
Managing Liquidity Risks Effectively
These risks and challenges have no doubt been detrimental for many in the sector and have indeed led to closure in some instances. Those firms that have been managing their liquidity effectively and have maintained good relationships with their supplier, banks and financial institutions have been able to show resilience and continue.
Both traditional and alternative sources of cash provide liquidity options that may support a company’s financial stability. Manufacturers can benefit from working with an insurance and risk adviser to have a better understanding on how to protect their bottom line and understand their total cost of risk to their business. This understanding can help you make informed decisions on how much risk to take on your balance sheet and what risks you should mitigate against.